JPMorgan: Bull Case Of $132, Bear Case Of $73

| About: JPMorgan Chase (JPM)
This article is now exclusive for PRO subscribers.

Summary

Through a series of articles, we are trying to quantify the impact of higher rates/lower taxes/less regulation on large-cap U.S. banks.

In this piece, we are focusing on JPMorgan.

Using a set of scenario-based valuation forecasts, we estimate that, in a bull case scenario, a fair value of JPM is $132 per share.

In our worst-case scenario, JPM’s fair value could touch $73 per share.

If you have read our prior articles on JPMorgan (NYSE:JPM), you will know that the bank has been our top pick in the U.S. banking space for quite a long time now. JPMorgan is a quality name. It is a premium franchise with above-average profitability levels and best-in-class shareholder yields. It is important to note that, as one of the very few U.S. banks delivering excess returns, JPM continues to generate value for its shareholders. As we mentioned, there are still several important catalysts for U.S Financials coming this year: 1) higher interest rates; 2) a lower corporate tax rate and 3) a more favorable regulatory environment. In this article, we are estimating how those catalysts will affect JPM's financials and, more importantly, its fair value.

Bull-Case Scenario

Despite the fact that JPM has a higher deposit beta, compared to Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC), it is still one of the biggest beneficiaries of a rising interest rate environment due to its variable-rate loan book and FICC division (Fixed Income, Currencies and Commodities). As a reminder, JPM is more weighted towards the rates business, compared to Bank of America (biased more to credit trading or Citigroup (NYSE:C). Uncertainty around actions by global central banks bodes well for strong results of the Rates segment.

Below is our earnings model for JPM. It values JPM at $106, implying around 17% upside to current prices. As our model suggests, we are bullish on the bank's non-interest income, due mainly to strong IBD/FICC revenues.

Source: Renaissance Research

In our base-case scenario, we assume that the bank's NIM (net interest margin) should increase by 15bps in 2017 and by 7bps in 2018. If we incorporate higher interest rates/bond yields, we will get the following numbers, which suggest that JPM's fair value is $114 per share.

Source: Renaissance Research

Similar to Bank of America's valuation model, to quantify the positive impact from potential tax cuts, we assume a 20% effective tax rate for 2017/2018.

Source: Renaissance Research

The model above suggests that JPM's fair value is $121 per share.

Finally, we are quantifying the impact of a more favorable regulatory environment.

Source: Renaissance Research

If we incorporate all the catalysts in our earnings model, we will get the following results. The numbers give a fair value of $132 per share.

Source: Renaissance Research

To recap, here is a table that demonstrates JPM's fair value in different scenarios.

Source: Renaissance Research

Bear-Case Scenario

Several analysts and investors have raised concerns (perhaps, rightfully) about higher cost of risk on car loans and credit cards. Although there are no signs of asset quality issues yet, we do believe that credit losses have bottomed out. In our view, the U.S. banking sector reached a point where loan loss provisions should begin to rise. As such, even in our base-case scenario we expect a material pick-up in JPM's cost of risk (+4bps/+5bps in 2017/2018). It is important to note that higher interest margins and stronger fees & commissions income should offset rising provisioning charges.

Source: Renaissance Research

If we assume a more pronounced spike in credit costs, we will get the following estimates. As the table below shows, a mild deterioration in asset quality should not be an issue for JPMorgan.

Source: Renaissance Research

A lower-for-longer interest rate environment would have a negative impact on margins.

Source: Renaissance Research

Finally, we run a worst-case scenario, where all of the assumptions turn against JPMorgan.

Source: Renaissance Research

To summarize, below is a table that shows JPM's fair value in different scenarios, including a worst-case scenario.

Source: Renaissance Research

As a buy-side analyst and a deputy portfolio manager, I oversee a financials-focused fund and will be continuously providing research coverage on developments with JPMorgan and other global banks. If you would like to receive our articles, consider following us by clicking the "Follow" button beside our name at the top of the page. Thank you for reading.

We also invite readers to check out our recently launched subscription service. Get in-depth fundamental research, stock recommendations, trading ideas, exclusive access to professional databases, sophisticated valuation models and expert commentary on Wall Street recommendation from a hedge-fund analyst with a proven track record. Go here to learn more or to sign up, we look forward to having you on board.

Disclosure: I am/we are long JPM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.